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Explaining operating profit
Episode 13823rd October 2022 • I Hate Numbers: Business Improvement and Performance • I Hate Numbers
00:00:00 00:06:43

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Explaining operating profit is this weeks I hate Numbers podcast.  Operating profit is a performance measure that tells you how much money your business earned from its core operations. It's a figure that business often overlook when it comes to budgeting and long-term planning.

But understanding your operating profit is essential if you want to make the most of your resources. This podcast breaks down some key points about operating profit and gives examples of how you can use this information for your business or organisation.

So, what exactly is operating profit?

Quite simply, it's a measure of all the revenue generated from a company's primary activities, minus all the associated costs. This includes things like the cost of raw materials, labour, factory overheads, and marketing expenses.

Operating profit is therefore a more accurate measure of a company's profitability from its ongoing activities.  And it's this figure that managers should focus on when making decisions about where to allocate resources.

So, next time you're looking at your company's financial statements, take a closer look at the operating profit figure. It will give you a better idea of how your business is performing

Good to know

Are you ready to have an easier and more rewarding relationship with your numbers?  My book, I Hate Numbers helps you get there.

This book is based on my 27 + years in business, helping thousands of businesses survive and prosper.  It is an easy, humorous but serious read about running a business, having a financially rewarding relationship with your numbers, Furthermore, my book will help with that battle between the ears, that all business owners experience.

Get in touch with us to help make your life easier and stress-free. Contact us if you need help figuring out and sorting your numbers, creating your future financial story plans, your taxpayroll and other accounting and business matters

This podcast uses the following third-party services for analysis:

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Profits is used widely as a performance measure. It measures how well you are performing in your business and what profit, in particular, operating profit is used very widely. In this broadcast, I'm going to explain what operating profit is, I’m going to explain how we calculate it, and I'm also going to look at why it's such an important metric, an important measure that we as business owners should understand and use in our business to power it forward.


You're listening to the I Hate Numbers podcast with Mahmood Reza. The I Hate Numbers Podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.


Hi folks. My name is Mahmood. I am the founder director of the accounting firm I Hate Numbers and also of the financial storytelling platform Numbers Know How. My mission over the last 27 plus years has always been to help business owners make more profit, increase their financial awareness, help them win more battles than they lose for what goes on between the ears, help them save time, save tax and have the businesses they aspire to do. That's a pretty good objective in my eyes. Let's crack on with the podcast.


Now, first of all, let's have a look at the idea of operating profit. And the first thing we need to get to grips with is there a multitude of terms you are likely to encounter for what operating profit is. You may come across the term net profit. You may also come across the term EBIT and PBIT, two acronyms which stand for as follows. EBIT represents earnings before interest and tax, and PBIT is profits before interest and tax. As a side note folks, by the way, earnings is that umbrella term that means profits. So we first of all got four different terms that you're likely to encounter. Operating profit, also called net profit, also called EBIT and also called PBIT.


Having gone through that variety of terms that we can use, let's have a think about how we calculate it. Now, the idea of operating profit is we're comparing effectively three numbers. We're looking at the value of what we sell as a business, as an organisation, what we call turnover. We then take off two groups of costs. We first will take off that group of costs, which are called cost of sales or direct costs. More of that in a few moments. And then lastly, we've deduct all the operating expenses of our business.


Let's compare and contrast two examples. An artist - put yourself in the shoes of an artist making their living, making their business income through selling works of art. They charge for those works of art and they have to spend money on paints, on canvases, and they also spend money on renting a studio. Having an admin person helps them set up a studio also money spent on marketing, money spent on bookkeeping. Let's throw some numbers to reinforce that. Now, our artists, in this example, sells works of art during the course of the year and sells them for a magnificent £60,000.


Substitute the currency of your choice. They also spend £20,000 on paints, on canvases on which to display their talent, and they also spend another £20,000 on the rent of the studio, the admin, the support, the marketing, et cetera. Now, out of those three numbers, the gross profit our artist is earning is the £60,000 worth of turnover, less than £20,000 worth of paints and canvases. That gives them what's called a gross profit of £40,000. Out of that, £40,000, they then have to cover the admin, the marketing, the rent of the studio, and that gives them 40, less 20, another £20,000. And the operating profit from that artist is £20,000.


Doesn't matter the shape of the business. If we looked at a restaurant tour selling the food, taken to count the outside catering they might be doing, they take off the cost of the food. Let's say it's £100,000 worth of sales, it's £40,000 worth of food purchases, etc. That gives you a 60,000 pound gross profit. The cost of renting the restaurant, the marketing, the staff wages, or another called 20,000. And that gives them a 40,000 pound operating profit. Now, having got that figure, what uses it to us? Well, it serves as a useful benchmark. It also serves as a very good indicator to judge the managerial competence, the efficiency of us and our management team of running the business. What's the core level of profits?


We know that if we manage to sell more our rent, our running costs will stay the same and operating profit is going to go that way. If, unfortunately, we catch a chill and turnover drops, the underlying operating costs will remain the same and the operating profit will decline downwards. Couple more things just to throw into the mix, folks. We could, if we wish to, and it's really a useful way of doing it, express our operating profit in proportion or percentage terms. So if we take the example of our artist, we had £60,000 worth of sales, we had £40,000 worth of paints, rent, etc. That gave us a 200 pound operating profit. If we divide 20 by 60 and times it by 100, that gives us 33%.


And that is the operating margin percentage that we're earning. If we sell more, then the operating percentage goes up, and if we sell less, the operating percentage goes down. So operating profit can be expressed in both currency form, dollars, pounds, take your pick, or in percentage terms. Both of them are really useful. Folks, I hope you found this video useful. I'd love it if you give some comments, tell me what you think. Do you calculate the operating profit for your business? Do you know what it is? If not, give it a go. Check out the show notes, and I'll give you a link to some further resources that will help you in your business. Until next week, folks, happy calculating.


We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.





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